The Worlds Largest Islamic Economy Is Coming Back Online - Clementine Brown

Interesting article from Clementine Brown on the opening of the Iranian market to Islamic finance and the perceived potential for juristic differences.
"The differences...are less significant than often claimed, and with interaction and collaboration, there is an opportunity for an overall refinement of Islamic finance practices"

Transcription

The world ’s largest Islamic economy is coming back online. But will Iran’s potential be hampered by Sunni-Shi’i differences? By Clementine Brown Iran is coming back online. Emerging markets enthusiasts are poised to buy into one of the last markets to be opened up to the world when sanctions lift. Yet despite Shi’i Iran having the largest Shari’ah-compliant economy globally, the Sunni Islamic finance sector is full of reservations. This article seeks to assess the instances where Iranian practice diverges from the rest of the Islamic finance world. The Myth (?) Decades of political hostilities between Shi’i Iran and Sunni countries have left their mark on attitudes in the Islamic finance world. Commentators and scholars repeatedly compare the Iranian version of Islamic finance unfavourably with the rest of the Middle East and Malaysia; a paper published by the International Islamic University of Malaysia writes-off Iranian sukuks (Shari’ah-compliant bonds) as “dummy versions” of their Sunni equivalents. Some Sunni scholars have questioned the “rightfulness” of Iranian banks (The Diplomat, June 2015). Even in the non-Muslim world, the obscurity of the Iranian market over the last decades has led investors to attach a risk-premium to Iran. Their reaction to the lack of information has been to assume the worst. Yet if we scrape back the mud which – for reasons of political bias, ignorance or fear – has been slung at the Iranian Islamic finance industry, these claims overstate the differences and mask the huge opportunity in Iran for the Islamic finance world. The Reality Despite divergences in methodology and base texts, particularly in the range of hadith (narrations of the life of the Prophet), of the two jurisprudential systems, which have often led to mutual suspicion, there are areas of substantial crossover. Equity investments in halal (‘permissible’) companies, for instance, fall easily within Sunni and Shi’i Shari’a compliancy. Even where the preceding methodology is different, investigating the similarities between Sunni sukuks and the four currently offered by the Iranian government shows considerable overlap. Musharakah sukuk accounts for the majority of bond issuance in Iran. Called ‘participation bonds’, they give the owner a percentage stake in governmental public works projects such as the building of a dam. As an asset-backed and profit-sharing instrument, it is hard to get musharakah wrong. The differences, according to experts at the Securities and Exchange Organization (SEO), are limited to not having rating agencies or using SPVs as the issuing entity. Professor Iraj Toutounchain, economic theorist and Islamic Finance expert, though sceptical about the sukuk market in general, says “[Iran’s] musharakah sukuk seems to be no different from that in Saudi Arabia”. Ijarah: A 2009 report by a Dubai-based scholar in The International Journal of Islamic and Middle Eastern Finance and Management on the then newly-issued ijarah sukuk found it complied with the Shari'ah requirements against riba (simply, ‘interest’) and gharar (‘deceptive uncertainty’). The markets for murabahah and salam sukuk are comparatively very small. Murabahah sukuks can have multiple different structures, and there is disagreement within the Sunni camp, as well as between Sunni and Shi’i theologians, as to their permissibility. The 2013 Semi-annual Bulletin of Iranian Islamic Capital Market (IICM) found Sunni and Shi’i jurisprudence to be unanimous on two of four types of murabahah sukuk. One of the points of contention within murabahah sukuk is the use of bay’ al-dayn (the trading of debt). Permitting sale of debt (dayn), especially at a lower value than the nominal value (which constitutes devaluation) provides an important solution for funding requirements of governments and economic corporations. Famous Shi’i, Shafi’i (Sunni) and Maleki (Sunni) jurisprudents permit the sale of dayn, while Hanafi and Hanbali (both Sunni) jurisprudents consider it an instance of riba and prohibit it. Therefore, based on most Islamic schools, it is possible to use this mechanism in

designing and issuing global financial instruments such as murabahah sukuk . Malaysia has issued both domestic and global murabahah sukuk. Another controversial issue between Islamic schools is the permissibility of bay’ alinah (a sale and buy-back agreement). One party sells the other an asset with deferred payment, which is immediately resold at spot price. Hence the first party is required to pay a certain amount in the future, but receives a slightly lower amount of cash today. This type of transaction is allowed in Malaysia under the Shafi’i school, but is rejected in Gulf countries as impermissible. Bay’ al-inah is seen by the Maliki and Hanbali schools as invalid, and by the Hanafi school as defective. The Shi’i school, too, rejects bay’ al-inah if the second transaction (sale) is conditioned under the first transaction (sale); therefore, in Iran, capital market issuance of murabahah sukuk based on bay’ al-inah (when seller and buyer of an asset is the same) is forbidden. Here is an example of a rejection in Iran of what is compliant with some Sunni schools. Salam: The use of the salam sukuk in Iran, though not a significant proportion of the Iranian capital markets, is a concrete instance of divergence. The structure was disallowed in 2007 by The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and is often cited as a reason why Iran’s system is different. It is worth noting that AAOIFI is a voluntary organization whose decisions are not binding in any country. Professor Toutouchian points out that most transactions of Iranian banks are kept in compliance with AAOIFI’s rules and guidelines, except for those that have been affected (directly or indirectly) by sanctions, for which there was no provision from AAOIFI (such as the government’s huge and everincreasing bank debts). Indeed, Emad Mostaque, a London-based strategist at research company Ecstrat Ltd., has pointed out the potential problems of implementing this: If AAOIFI standards were adhered to, would Iranian bonds suddenly be deemed acceptable? To what degree would they need to be so? Who would need to stamp it? It is clear this dispute extends beyond regulatory intricacies. A Framework for Inquiry As a way to step back from these intricacies and draw a framework for the debate, two fundamental questions can be addressed: Firstly, who has the authority to say what is, and what is not, ‘Islamic’? Iran, whose Islamic finance assets exceed those of Saudi Arabia, Malaysia and the UAE combined, will from next year—pending US Senate approval and nuclear regulators’ authorisation—no longer be restricted from full participation in international financial markets. Under this new status quo, who will have the authority to say what is, and what is not, ‘Islamic’? This year has seen an increasing trickle of Iranian bankers on the guest lists of international Islamic finance forums. The Islamic finance debate, and organisations like AAOIFI whose board contains just one Shi’i scholar, will have to broaden their margins to accommodate the newcomers. Secondly, to what extent should Islamic finance allow for variance? In Sunni Islam, variation between the four main schools of jurisprudence is allowed if the usul (‘principles’) are sound. Though popular understanding would suggest the Ja’fari school, to which most of Iran belongs, is extremely different to Sunni schools, Sheikh Mahmood Shaltoot of al-Azhar’s 1959 fatwa states that “the difference between the Ja'fari and Sunni schools is not greater than the difference among the Sunni schools themselves”. When it comes to Islamic finance products, Majid Pireh, Islamic Finance Senior Expert at Iran’s market regulator, the SEO, endorses this view: “in most structures in Islamic capital and money market, similarities between Sunni and Shi’i Shari’ah boards are very high”. Mohammad Fetanat, chairman of the SEO, puts it in layman’s terms: “It’s like buying a smartphone; there is no Shia or Sunni smartphone, it’s just the same” he told The Diplomat. It is worth noting that similar accusations to those made of Iran’s Islamic finance structures have likewise been made of their Sunni parallels. In Mufti Taqi Usmani’s damning critique of the “deceptive stratagems” of all Sunni sukuk, he argues that most Islamic finance has tried to replicate conventional finance. Despite coming under fire from various Shari’ah boards for its similarity to interest-

bearing loans , the tawarruq instrument currently makes up around 75% of Islamic investments. “Scholars who approve tawarruq are commercial pragmatists and indeed approval of ‘organised’ tawarruq is generally considered a moderate position,” said Harris Irfan, author of Heaven’s Bankers. To some it smacks of hypocrisy to see scholars signing-off tawarruq with one hand whilst reproaching others for insufficient conservatism with the other. Indeed, norms such as the 5% limit for haram revenue (e.g. from the selling of alcohol) in equity investments have scant scriptural backing. Allowing for variation does not have to mean applying the ‘Islamic finance’ label carelessly. Scholars have acknowledged that whilst instruments like tawarruq had their place in getting Islamic finance off the ground (as a viable alternative to conventional finance), now the industry as a whole should work towards ‘refining’ its structures. “If Iran needs to be a part of that refining process, it will be alongside other Islamic finance centres,” points out Harris Irfan. Iran has already begun refining its structures. In anticipation of sanctions lifting, when companies will seek to raise capital to fund expanding operations, the SEO is making plans to boost the Islamic bond market and is adjusting sukuk contracts as well as developing new Shari’ah-compliant contracts, according to Majid Pireh. “Nowadays, with declining international pressures on Iran and the increasing possibility of Iranian presence in financial markets, it is an unbeatable opportunity to engage with international markets by designing and issuing international Islamic instruments. Undoubtedly, to realize this affair we should try to design and develop new instruments based on the similarities between different Shari’ah schools (Sunni and Shi’a) and the acceptable principles of Shari’ah boards of Islamic countries.” "In terms of Islamic financial instruments, the new President has emphasised the development of the sukuk market in Iran". One plan is the introduction of new governmentguaranteed Islamic treasury bills, which have better liquidity than comparable securities. The potential of Iran is huge. As the only fully Shari’ah-compliant banking system that is similar to, though not exactly the same as, the Sunni one, it represents a massive opportunity for the Islamic finance industry to expand and further its cause of building a more sustainable economy. “While most Shari’ah bonds are now trading in line with or at a premium to their conventional equivalents, Iranian bonds will be coming to the market with 20%+ yields and a currency that is likely to stay stable or even appreciate as foreign money comes into the country,” says Emad Mostaque. If Islamic finance is to build on its now well established reputation, both sides will need to raise their awareness of the other's legal principles, hadith sources, and juristic styles for proper mutual understanding. The differences, this article has found, are less significant than often claimed, and with interaction and collaboration, there is an opportunity for an overall refinement of Islamic finance practices.